In contrast, a blog post in The Wall Street Journal demonstrates that the December rally is more pronounced and consistent across observation timeframes than the January one, which vanished in the last 20 years:

This finding is less meaningful because it only determines the magnitude of monthly oscillation, rather than a complete return in each month.

According to the post, an interesting return pattern emerges in the last and first month of the year:

A pullback in the middle of December is caused by tax-loss selling by traders, window dressing by fund managers, and portfolio realigning by investors. Once this is over, a rally ensues. However, according to the article, it is statistically significant only in a short period at the turn of the year:

There is one version of the Santa Claus rally that enjoys strong historical support: the last five trading sessions of December and first two of January… Since the Dow was created in 1896, it has gained an average of 1.7% during this seven-trading session period, rising 77% of the time. That is far better than the 0.2% average gain of all other seven-trading-session periods of the calendar.

Here is how the S&P 500® returns look so far this December, as compiled by Alpholio™:

Despite a pullback early in the month, there is some similarity to the above long-term average return pattern. Of course, only time will tell if the rest of the pattern is followed.

The seasonal effects are mostly pronounced in small-cap stocks. In addition, the report claims that lower-quality stocks strongly outperform in January:

Loading up on “junk” equities for the sake of a superior one-month return is probably not advisable. If anything, this might be an opportune time to tilt the portfolio towards high-quality, cash-rich companies, which Merrill Lynch itself recommends in its 2014 outlook. Seasonal market trends, such as the Santa Claus rally or January effect, no matter how likely, should not cloud a long-term investment perspective.

At year’s end, many analysts make market predictions for the next twelve months. The S&P 500® index is a popular target for such forecasts since it is commonly used as a market proxy and its constituent stocks are widely followed. Hence the bottom-up analysis — a sum of estimates for all individual equities makes an index forecast.

Who better to predict the S&P 500® index level than the S&P itself? Let’s take a closer look at their forecast accuracy. The following chart compares the predicted to actual values of the index, which Alpholio™ compiled from historical editions of S&P Capital IQ’s The Outlook:

To be exact, these 12-month targets were typically set in early to mid December of the preceding year, while the actual index values were recorded on the last trading day of the predicted year. Also, dividends were not taken into account in this price index.

The immediate takeaway from this chart is that the forecast for 2008 vastly overestimated the actual price: 1,650 vs. 903, or by about 83%! The financial crisis and its magnitude caught everyone, including members of the S&P Capital IQ’s Investment Policy Committee, by surprise. Excluding that outlier year, here are the index prediction and annual return statistics:

Statistic

Prediction vs. Actual

Actual Index Return

Average

-2.2%

11.8%

Median

-1.8%

13.1%

Standard Deviation

5.8%

9.2%

The sample is admittedly small, under ten data points. But a trend is emerging — on average, S&P predictions underestimated the actual index. This tendency is further illustrated by the following chart from FactSet’s Targets & Ratings report:

The chart shows how a bottom-up target price (dashed line) moved almost in parallel with the actual index (solid line) in the 12 months through October. In other words, predictions were adjusted upwards with a lag as it became evident that original estimates were likely going to be soon surpassed. (As a side observation, almost half the stocks in the S&P 500® were rated a Buy, slightly less than half a Hold, and only about 5% a Sell. Even a booming market, a less optimistic distribution would be intuitively expected.)

S&P offers another interesting prediction for the next year:

We also believe 2014 could be one of those years in which the S&P 500 is up for the entire year but suffers through a pullback of 5%-10% (and more likely a correction of 10%-20%) before ending the year higher than where it started. One reason is that 26 months have elapsed without the S&P 500 slipping into a correction, versus the average of 18 months (and median of 12 months) between declines of 10% or more since 1945.

If statistically the market is overdue for a correction, let’s also hope that by the same token S&P underestimated the 500® index’s value in 12 months from now. In that case, we should be expecting a price of about 1930 instead of the current target of 1895, while keeping in mind that perfect market predictions are virtually impossible.